Inside Jobs

The financial crisis of 2007 and 2008 was not only tragic, and devastating to millions of Americans, it was ridiculous.

It didn’t have to happen.

Twenty-two years ago Stephen Pizzo, Mary Fricker and Paul Muolo investigated the savings and loan crisis and wrote a book about it, “Inside Job, the Looting of America’s Savings and Loans.”[1]

After three years of crawling through the wreckage of America’s once vibrant thrift industry, we told our readers, and later testified before Congress, that we had learned two important lessons: Be careful about deregulation and get rid of bank secrecy.

Deregulation, we wrote, was like brain surgery – a little bit goes a long way. Cut away too much oversight and you can do more harm than good. We also warned that outdated rules encouraging bank secrecy, rather than protecting consumers, actually shielded, protected and empowered crooks.

Since then, bankers have deregulated themselves by moving half their business into the shadow banking system,[2] where they are less regulated and more secret than ever.

We are stunned and angered that regulators and politicians have let bankers pull another Inside Job, once again leaving taxpayers holding the bag for hundreds of billions of dollars in “losses.”

Twenty-two years ago we said in “Inside Job”:

“All that are left to salvage from the thrift industry carnage are lessons that we hope were learned. First and foremost is the clear message that there should be a careful reassessment of what can and cannot be deregulated in this country – and that deregulation is one thing while unregulation is something else entirely. Deregulating segments of the financial services industry is not, in itself, a bad idea. … Congress must learn to treat financial service deregulation like brain surgery, realizing that if too much is cut away, the patient will begin acting in bizarre, unpredictable, and often self-destructive ways.

“Deregulation as it was carried out during the Reagan administration benefited not mainstream business, as advertised, but financial rainmakers like Mike Milken, Charles Keating, David Paul, and a host of others who created nothing of lasting value while siphoning off billions of dollars from our national treasury.

“Lesson No. 2: It’s time to bury the depression-era fear of runs on banks. That phobia is one of the underlying justifications for the secrecy that surrounds bank and S&L actions, but, in fact, the best thing that could have happened to the thrifts in this book would have been an early run on deposits to force more timely action by regulators. Secrecy was the single most important factor in allowing losses at thrifts to get so large. It played directly into the hands of anyone who had something to hide. …

“Thrifts and banks must be opened to the light of day. Then, if depositors don’t like what they see and decide to take their money elsewhere, so be it. Examination reports, for example, should immediately be made public. If Vernon Savings’ depositors had discovered the kinds of screwball deals that that thrift was involved in when its assets were only, say, $300 million, and there’d been an ugly little run on deposits, forcing regulators to pay attention, think how much the FSLIC (the S&L equivalent of the FDIC in those days) would have saved.”[3]

In 1991 Pizzo and Fricker testified before Congress when it was studying ways to deregulate banks and let market discipline take over from regulators. We urged caution. We bring this up now to make this point: If small-time reporters understood these dangers 20 years ago, so did Congress, federal regulators and bankers. Among the points we made:

“Keeping bank deregulation from becoming a replay of thrift deregulation and the carnage that followed is one of the most dangerous challenges facing Congress. …

“If Congress opens up banking to Wall Street speculation, as it opened up S&Ls and banks to real estate speculation, regulators will quickly lose control over the complex series of events that a pervasive marketplace will immediately set in motion. Insider abuse, self-dealing, and back scratching relationships between institutions will run rampant.

“While speculators play an important role in a free market economy, their instincts and perspectives are exactly the opposite of those we want in our bankers. Wall Street investment bankers are to commercial bankers what fighter pilots are to airline pilots. One takes risks, the other avoids them. …

“Treasury Secretary Nicholas Brady is almost giddy over the prospect of merging banks and Wall Street. It makes sense, he says, because investment banking shares a ‘natural synergy’ with commercial banking.

“Sound familiar? The same argument was used a decade ago when savings and loans wanted to get into the construction and development business. Developers need loans – thrifts made loans. Bingo. Natural synergy. Regulations prohibiting such joint ventures were abolished, and sure enough private capital poured into the thrift industry as developers bought thrifts and thrifts acquired their own construction companies.

“‘My God! This is what I’ve been waiting for all my life!’ gasped the owner of (now defunct) San Marino Savings and Loan.

“Almost immediately the predictable happened. The historical arms-length relationship that had existed between lender and borrower vanished, and with it went due diligence, common sense and, in too many cases, ethics. Thanks to facilitating that bit of synergy the taxpayer is stuck with $300 billion worth of repossessed real estate from failed thrifts. If we sold $1 million worth of this stuff a day, it would take 800 years to sell it all. …

“The big ‘money center’ bankers argue that without deregulation American banks will not be able to compete with European banks after 1992, when the European Common Market will combine in a universal banking system with broad banking and securities powers. They also complain that they can’t compete with the Japanese banks that are flooding U.S. markets. They pointedly note that no American bank ranks among the word’s 10 largest banks.

“Bankers assure their critics that the potential dangers of corporate ownership and securities and insurance underwriting are moot issues because bankers will agree to impenetrable firewalls between their corporate, banking, securities and insurance affiliates. If the securities company gets into trouble, for example, firewalls will protect the bank’s federally insured deposits, they claim. Apparently, through some magical osmosis that only works one way, American are asked to believe that banks will enjoy the benefits of having securities affiliates without ever being affected by their problems. …

“There’s not a bank examiner in this country who could control such a corporate banking octopus. If S&L regulators couldn’t stop the looting at savings and loans – which are by comparison a fairly straight forward corporate structure – what hope is there that bank regulators will be able to monitor a two-tiered holding company structure with multiple affiliates and subsidiaries? …

“It is this antiquated and inadequate system Congress is about to ask to monitor banks involved in securities and insurance underwriting. Regulators will have to unravel the dealings of complex bank holding company structures, foreign transactions, national and international activities, sophisticated hedges and straddles and options and swaps and thousands of daily electronic transfers among affiliates and subsidiaries and brokers. …

“Bankers’ pleas for interstate branching should also be ignored. …

“The net result of interstate branching will be fewer banks and the consolidation of the industry into a group of mega-banks, each of which will then be perceived by regulators as being decidedly Too Big To Fail. …

“Banks’ demands for dramatic changes come at a time when banks are weaker than they have been since the Great Depression. Almost 1,000 banks have failed in the last four years, more than failed in the first 30 years after Glass-Steagall was passed. Restrictive regulations did not cause these problems, as the big banks would have Congress believe. Instead, in the last five years American bankers have discovered about $75 billion in bad loans on their books. With judgment that faulty, it’s terrifying to think what they could have done on Wall Street. Never ones to be contrite about losing other people’s money however, the bankers explain that in essence the devil made them do it. They say that it was those ‘old-fashioned federal regulations’ barring banks from other, potentially greener pastures that forced them into those bad deals.

“Others disagree. Irvine Sprague, FDIC chairman until 1986, said most bank failures are caused by one thing – greed. The Comptroller of the Currency said bad management is to blame. The General Accounting Office found insider abuse at 64 percent of the bank failures it studied. The FDIC reported that criminal misconduct by insiders was a major contributing factor in 45 percent of recent bank failures.

“A man who arranges mezzanine financing for leveraged buyouts told us not long ago, ‘I think I’ll go buy a bank. They only cost $3 million’ When an LBO player thinks a stodgy old bank is suddenly attractive, should Congress begin to worry?

“As for bankers who find themselves locked in this fatal attraction, they should turn for advice to some of their former cousins who pushed so hard for savings and loan deregulation. These former thrift operators might tell bankers to be careful what they ask for – they might just get it.“

After our 15 minutes of fame, we went home to cover the 1990s, which turned out to be an unsettling time, thanks to debt, derivatives, deregulation and dot.coms.

In 1994, Proctor & Gamble, Gibson Greeting, Atlantic Richfield, Dell Computers, Orange County and more than 100 others announced multi-million-dollar losses on investment strategies based on derivatives and repurchase agreements. The Mexican crisis in 1995, the Asian meltdown in 1997, the failure of the Long Term Capital Management hedge fund in 1998, the dot.com and telecom bubbles at the end of the decade, the conflicts of interest the bubbles exposed at investment banks and credit rating agencies, Enron’s collapse in 2001 and WorldCom’s failure in 2002 – all were warnings that financial markets were living on the edge. After the housing bubble appeared in 2003, we covered it for five years. In our respective roles – Pizzo was blogging and freelancing about politics, Fricker was a daily business reporter at a mid-sized newspaper, and Muolo was an editor of a national trade journal for the mortgage industry — we wrote about them all.

For a couple of years in the early 1990s, it seemed as if Congress had really listened to us and others, as they enacted several tough laws to fight fraud, shut down financial institutions promptly before they became insolvent, limit brokered deposits and fight insider abuses. They even abolished the federal agencies that had overseen the S&Ls, the Federal Savings and Loan Insurance Corp. and the Federal Home Loan Bank Board. Take that!

But banks revolted, and in the end they won. After the S&L crisis, regulators decided that the riskier a commercial bank’s business was, the more of its own money it had to set aside for emergencies. We thought that was a great idea. But banks promptly set about gaming these regulations, with the full knowledge and approval of their regulators.

During the decade, banks shot down several efforts to make derivatives more transparent. By 1997 Congress had phased in interstate branching. In 1999 it allowed one company to own commercial banks, investment banks, insurance companies and other types of business.[5] By 2000 the rush to become Too Big To Fail was on. Between 2000 and 2007, the 10 largest U.S. financial institutions more than doubled in size.[6]

In July 2008, two months before the meltdown, Muolo and Orange County Register reporter Mathew Padilla authored “Chain of Blame” published by John Wiley & Sons, Inc. It is a detailed expose of the rise and fall of housing, in which they show how the nation’s largest investment and commercial banks and thrifts controlled the subprime pipeline, from the mortgage broker on Main Street to the traders on Wall Street.

As soon as we started digging into the financial crash, we started to feel very much at home.

Here was Federal Reserve Board Chairman Alan Greenspan extolling the brilliance of free markets and the financiers who manipulated them, just as 20 years earlier he had praised S&L deregulation[7] and his employer, Charles Keating, later convicted of fraud.

Here was Darrel Dochow, an S&L regulator who recommended playing ball with Keating and, 20 years later, did the same for the failing IndyMac.[8]

— Like the “rolling loans that gathered no loss.” In the S&L days, thrifts kept loans from default by extending them. In the subprime days, banks kept loans from default by modifying them, a wrinkle they called “extend and pretend.”[10]

— Like “cash for trash.” In the S&L days, thrifts lent borrowers more money than they needed and required the borrower to use the extra cash to buy a troubled property on the thrift’s books. In the subprime days, banks made repo loans to borrowers, who used that money to buy troubled mortgage securities on the banks’ books and then used the troubled securities to collateralize the original repo loan from the bank. Or banks got a repo loan from a trust, using troubled real estate loans as collateral, so the trust could turn the bad loans into AAA-rated securities, so the banks could use the repo loan to buy them and use them as collateral for another repo loan.[11]

— Like ADC loans in the S&L days and SFDP loans in the subprime days. In the S&L days, the borrower’s interest payments were added to the amount of his acquisition, development and construction loan. In the subprime days, the borrower’s down payment was added to the amount of the seller-funded downpayment program loan. Lenders racked up fees, property values inflated and construction escalated rapidly. As a result, in the S&L days we had “see-through” office buildings.[12] In the subprime days we had “see-through” condo towers.[13]

The regulators’ response didn’t change much either. In both periods, forbearance was the name of the game.[14] And when that failed, as it usually does, the solution to both the S&L and subprime crises was exactly the same: Bring in the taxpayers.

We support prosecuting fraud. Who doesn’t? But honestly we can’t see that the threat of criminal prosecution does much to deter a gold digger with the gleam of riches in his eye. Our justice system prosecuted more than 1,000 cases of fraud from the S&L scandal. That didn’t stop today’s financial cartel from cooking their books, selling rotten securities to unsuspecting investors, forcing losses on competitors, tricking borrowers with indecipherable contracts, snookering public agencies into taking on risk and debt, and helping clients break tax laws.

We also applaud bank regulators’ vows to be quicker, tougher, smarter next time. But history has taught us not to hang our hats on that one. It’s hard to blame the financial crisis on deregulation when everyone in central casting was so heavily regulated. Teams of bank regulators worked full time at the large commercial banks. The New York Federal Reserve Bank, headed by now-U.S. Treasury Secretary Timothy Geithner and a board of directors made up of people like Lehman Brothers CEO Richard Fuld, was intimately involved with the shadow institutions on a daily basis. All of the problems the banking system has faced in the last three years – and S&LS two decades ago – were widely studied, heavily debated and well known for years.[15] Regulators had the knowledge and authority they needed to head off disaster. They just didn’t use it.[16]

If these people didn’t learn their lesson after scores of S&Ls were abducted by a band of crooks, we give up. They will never learn.[17]

What’s our solution? It’s the same as it was 22 years ago: Be careful about deregulation and get rid of bank secrecy.

[1]Pizzo, Stephen, Mary Fricker and Paul Muolo, “Inside Job, the Looting of America’s Savings and Loans,” McGraw-Hill Publishing Company 1989, HarperCollinsPublishers 1990. Please read the HarperCollins paperback, which was updated, and not the hard cover by McGraw-Hill or the Kindle version, which hide or delete important footnotes.

[7]In “Inside Job” we wrote: “He (Greenspan) wrote that deregulation was working just as planned, and that now was not the time to get cold feet just because a few problems had popped up. Greenspan went on to name 17 thrifts, including (Keating’s Lincoln Savings & Loan), that had reported record profits and were prospering under deregulation. Four years later, 16 of the 17 thrifts Greenspan had mentioned in his letter would be out of business.” Evidently Greenspan didn’t feel any lesson was to be learned there.

[8]By 2008 Dochow was top thrift regulator in the western states, where he oversaw some of the most dramatic flame-outs including Washington Mutual, Countrywide Financial, IndyMac and Downey Savings and Loan.

Watching for the next bubble

From the editor

To understand the financial crisis of 2007-2008, and to prevent the next one, you must understand the repurchase market.

Consider This

The financial crisis was not caused by homeowners borrowing too much money. It was caused by giant financial institutions borrowing too much money, much of it from each other on the repurchase (repo) market. This matters, because we can't prevent the next crisis by fixing mortgages. We have to fix repos.

Quotes in the News

"Securities lending was partly responsible for the collapse of the large insurance company AIG when the market seized in September 2008." -- Economists Stephen G. Cecchetti and Kermit L. Schoenholtz, November 7, 2016.
*****
"Data describing bilateral repurchase agreements and securities lending were scant in the run up to the financial crisis, and they still are." -- Richard Berner, director, Office of Financial Research. October 27, 2016.
*****
"The crisis brought to light unique risks from the excessive use of short-term wholesale funding and repo agreements in particular .... Looking back, it is easy to see how certain behaviours and market practices necessitated government intervention with wholesale funding and collateral management reforms becoming a cornerstone of global regulators’ post-crisis efforts to reduce risk in the financial system." -- James Slater, global head of
securities finance at BNY Mellon Markets, Securities Lending Times. September 29, 2016.
*****
"I continue to believe that the post-crisis work to create a solid regime to protect financial stability cannot be deemed complete without a well-considered approach to regulating runnable funding." -- Federal Reserve Governor Daniel Tarullo. July 12, 2016.
*****
"After four years of efforts, regulators and the financial firms with the most at stake have failed to extinguish systemic risk in a crucial short-term lending market (the repurchase market} that greases the wheels of trading in U.S. Treasuries." -- Liz McCormick, Bloomberg. May 25, 2016.
*****
"If a bank goes bankrupt, derivatives and repo counterparties can just demand their money back as though the Bankruptcy Code doesn't exist." -- Matt Levine, BloombergView. May 4, 2016.
*****
"The Great Financial Crisis of 2007-2009 exposed the ineffectiveness of the relevant regulations in place at the time. Yet even now and despite the crisis, the rules remain inadequate and flawed." -- Anat R. Admati, professor Graduate School of Business, Stanford University, May 2016.
*****
"Data gaps persist in securities financing transactions, including repo and securities lending. The markets for these critical short-term funding instruments remain vulnerable to runs and asset fire sales. Yet comprehensive data on so-called bilateral repo and securities lending transactions are scant." -- Richard Berner, Director, Office of Financial Research. April 12, 2016.
*****
"As we look to the future of U.S. wholesale funding, we expect repo to serve as the circulatory system for broader financial markets who have become increasingly reliant on the smooth transfer of collateral." -- BNY Mellon and PwC Financial Services, "The Future of Wholesale Funding Markets," December 10, 2015.
*****
"Market interest rates are effectively determined in the collateral market, such as the repo, or repurchase market, where banks and other financial institutions exchange collateral (such as US Treasuries, mortgage securities, corporate debt, equities) for money." --Manmohan Singh, Financial Times, November 23, 2015.
*****
"In many ways, repos are the building blocks of financial markets. To mess with repo is to mess with the DNA of the markets." -- Andy Hill, International Capital Market Association. September 2015.
*****
"The market for repurchase agreements is an elemental building block of modern financial markets. Whether used as a money market instrument, a source of funding, a means of mobilising collateral, or the transmission mechanism for monetary policy, it is difficult to think of any financial instrument or derivative that is not impacted in one way or another by repo rates." -- Andy Hill, International Capital Market Association. September 2015.
*****
"Nearly half of the liabilities of broker-dealers consist of short-term wholesale funding (repo and securities lending), an amount that is nearly the same as it was during the crisis." -- Federal Reserve Governor Daniel Tarullo, Brookings Institution, November 17, 2015.
*****
"I also believe that the greatest risks to financial stability are the funding runs and asset fire sales associated with reliance on short-term wholesale funding ... If there is one lesson to be drawn from the financial crisis, it is that the rapid withdrawal of funding by short-term credit providers can lead to systemic problems as consequential as those associated with classic runs on traditional banks." -- Federal Reserve Governor Daniel Tarullo, Brookings Institution, November 17, 2015.
*****
"Given its vast scale and position at the center of the wholesale finance markets, repo is without doubt a critical activity. " -- Federal Reserve Governor Jerome Powell, Clearing House Annual Conference, November 17, 2015.
*****
"For the most part, the main problems during that (financial) crisis didn't involve banks that offered both commercial and investment services. Instead, the problems were primarily at traditional investment banks. Had Glass-Steagall remained in place, the financial crisis would almost surely have happened anyway." -- Mark Thoma, MoneyWatch, November 16, 2015.
*****
"Despite of its systemic importance, the repo market remains opaque to most market participants, including even the regulators. Because no official data on repos exists, questions as basic as the overall size of the market are difficult to answer." -- Grace Xing Hu, Jun Pan, Jiang Wang, Tri-Party Repo Pricing, August 2015.
*****
Financial panics are increasing in frequency. While they used to be driven by depositors lining up to get their money, nowadays, "the problem is that institutional creditors do the same thing in the repo market." -- John Maxfield, The Motley Fool, March 19, 2015.
*****
"The repo market, the largest short-term funding market ... still remains susceptible to asset fire sales and runs." -- Office of Financial Research, December 2014.
*****
Repo “is the most important plumbing of the financial system. If the industry cannot come up with a solution, there is some implicit suggestion the Fed would have to step in in a more direct way." -- Darrell Duffie, professor of finance at Stanford University, October 9, 2014.
*****
"Without repo, there is no leveraged positioning in financial markets; without leverage and the constant hypothecation there is nothing to maintain the stock market's exuberance." Repo markets provide "the glue that holds stock markets together." -- Tyler Durden, Zero Hedge, June 27, 2014.
*****
"The Repo market includes both the banking system and the shadow banking system, all in one place. It’s the overnight borrowing and lending market of the entire financial system." -- Scott E.D. Skyrm, May 21, 2014.
*****
"The potential for repo markets to act as a channel for financial instability in the event of (or perception of) financial distress at a large dealer remains .." -- Standard and Poor's, May 13, 2014.
*****
"Regulators and policymakers currently have no reliable, ongoing information on bilateral repo market activity." -- Financial Stability Oversight Council, May 7, 2014.
*****
"These runs were the primary engine of a financial crisis from which the United States and the global economy have yet to fully recover." -- Federal Reserve Chair Janet Yellen, April 15, 2014.
*****
"The banks remain dangerously interconnected and vulnerable to sudden runs because of their dependence on short-term, often overnight borrowing through the multitrillion-dollar repurchase agreement, or repo, market. -- Jennifer Taub, associate professor, Vermont Law School, April 4, 2014.
*****
"The 2007–2008 financial crisis was driven more by disruptions in the Securities Financing Transactions markets than by disruptions in the over-the-counter derivative markets." -- Federal Reserve Governor Daniel K. Tarullo, November 22, 2013.
*****
“The money market fund industry and the repo market is really the major fault line that goes right under Wall Street." -- Dennis Kelleher, CEO of Better Markets, Bankrate.com, July 24, 2013.
*****
Repo: "The silently beating heart of the market." -- Treasury Borrowing Advisory Committee, July 2013.
*****
Under Basel capital rules, "repos among financial institutions are treated as extremely low risk, even though excessive reliance on repo funding almost brought our system down. How dumb is that?" -- Sheila Bair, chair of the Systemic Risk Council and 2006-2011 Chair of the FDIC, June 9, 2013.
*****
"The trigger for the acute phase of the financial crisis was the rapid unwinding of large amounts of short-term wholesale funding that had been made available to highly leveraged and/or maturity-transforming financial firms." --Janet Yellen, Vice Chair Federal Reserve, June 2, 2013.
*****
"The repo market wasn’t just a part of the meltdown. It was the meltdown." --David Weidner, Wall Street Journal, May 29, 2013.
*****
"While regulated banks have faced far tighter oversight following the financial crisis, the shadow-banking market remains a source of potential instability. It is worth remembering that runs here, rather than traditional bank runs, were a cause of the crisis and led to seizures of credit markets." -- David Reilly, Wall Street Journal, February 19, 2013.
*****
"It is worth recalling that the trigger for the acute phase of the financial crisis was the rapid unwinding of large amounts of short-term funding that had been made available to firms not subject to consolidated prudential supervision." -- Daniel K. Tarullo, Federal Reserve Governor, February 14, 2013.
*****
"I don’t think we should be comfortable with a situation in which extensive maturity transformation continues to take place without the appropriate safeguards against runs and fire sales." -- William C. Dudley, President, Federal Reserve Bank of New York, February 1, 2013.
*****
"The global financial crisis that began in the United States in the summer of 2007 was triggered by a bank run, just like those of 1837, 1857, 1873, 1893, 1907, and 1933 ... and it has had devastating effects that continue today." -- Gary B Gorton, Yale University, "Misunderstanding Financial Crises," November 2012.
*****
"Currently, the drivers of systemic risk remain largely intact, and shadow banking appears poised to grow considerably, and dangerously, if it does not acquire the necessary market discipline to shape risk-taking activities." -- From "Understanding the Risks Inherent in Shadow Banking" by David Luttrell, Harvey Rosenblum, and Jackson Thies, Federal Reserve Bank of Dallas, November 2012.
*****
"The essence of shadow banking is to make loans, securitize them, sell the securities and insure them, and actively trade all the financial assets involved. In effect, traditional relationship banking is replaced by a collateralized market system with the repo market at its heart." --William R. White, Organisation for Economic Co-operation and Development, August 2012.
*****
"What was different about this crisis was that the institutional structure was different. It wasn't banks and depositors. It was broker-dealers and repo markets. It was money market funds and commercial paper ...," --Federal Reserve Chairman Ben Bernanke, March 27, 2012.
*****
"The Federal Reserve was forced to take extraordinary policy actions beginning in 2008 to counteract the effect of (tri-party repo) flaws and avert a collapse of confidence in this critical financing market. These structural weaknesses are unacceptable and must be eliminated." --Federal Reserve Bank of New York, February 15, 2012.
*****
"Despite the Dodd-Frank financial reform bill and its directive to address this issue, the problem of bank runs in the shadow system -- a key factor in the financial sector collapse -- has not yet been solved." --Mark Thoma, Professor of Economics, University of Oregon, February 13, 2012.
*****
"Repurchase agreements (repo) are the largest part of the 'shadow' banking system: a network of demand deposits that, despite its size, maturity, and general stability, remains vulnerable to investor panic." --Jeff Penney, senior advisor, McKinsey & Company, June 2011.
*****
"What happened in September 2008 was a kind of bank run. Creditors lost confidence in the ability of investment banks to redeem short-term loans, leading to a precipitous decline in lending in the repurchase agreements (repo) market." --Robert E. Lucas, Jr., Nancy L. Stokey, visiting scholars, Federal Reserve Bank of Minneapolis, May 2011.
*****
"The really interesting thing that happened in September 2008 was the worldwide panic in the banking system – financial institutions running on each other behind the scenes." –-David Warsh, economic journalist, Feb. 6, 2011.
*****
“As a scholar of the Great Depression, I honestly believe that September and October of 2008 was the worst financial crisis in global history, including the Great Depression …Out of maybe the 13 of the most important financial institutions in the United States, 12 were at risk of failure within a period of a week or two.” --Federal Reserve Chairman Ben Bernanke, Financial Crisis Inquiry Report, January 2011.
*****
"Since repo financing was the basis of most of the leveraged positions of the shadow banks, a large part of the run occurred in the repo market." --Viral V. Acharya and T. Sabri Öncü, professors, Stern School of Business, New York University, 2011.
*****
"Housing policies alone, however, would not have led to the near insolvency of many banks and to the credit-market freeze. The key to these effects was the excessive leverage that pervaded, and continues to pervade, the financial industry." --Anat R. Admati, Professor of Finance and Economics, Graduate School of Business, Stanford University. January 30, 2011.
*****
"Without some repo reform, we are at risk for another panic." --Gary B. Gorton, Professor of Management and Finance, Yale School of Management, November 16, 2010.
*****
"While it may be well and good for the Dodd-Frank Act to demand more oversight of mortgages and derivatives, that won’t stop the next run on repo if lenders panic over a different kind of collateral or hear a false rumor and panic for no reason at all." --About Repo, RepoWatch.
*****
The repurchase market is “the deepest, darkest least noticed part of the market’s plumbing.” --Bethany McLean and Joe Nocera, "All the Devils are Here," November 2010.
*****
“So far, all of this has gone largely unnoticed by the public, and that gives shadow banks the opportunity to make their case unopposed." --Mark Thoma, Professor of Economics, University of Oregon, September 28, 2010.
*****
"... the structure of the tri-party market is so closely entwined that it creates a contagion risk as bad as anything seen in the derivatives world." --Gillian Tett, U.S. managing editor, Financial Times, September 23, 2010.
*****
"The collapse in CDO valuations and the resulting inability to use CDOs as collateral for repo was a major, if not the major, cause of dealer illiquidity and insolvency which resulted in massive bailouts and backdoor subsidies." --Yves Smith, Naked Capitalism blog, August 20, 2010.
*****
"Repo has a flaw: It is vulnerable to panic, that is, 'depositors' may 'withdraw' their money at any time, forcing the system into massive deleveraging. We saw this over and over again with demand deposits in all of U.S. history prior to deposit insurance. This problem has not been addressed by the Dodd-Frank legislation. So, it could happen again. The next shock could be a sovereign default, a crash of some important market -- who knows what it might be?" --Gary B. Gorton, Professor of Management and Finance, Yale School of Management, August 14, 2010.
*****
"Leaving the repo market as it currently functions is not an alternative; if this market is not reformed and their participants not made to internatlize the liquidity risk, runs on the repo will occur in the future, potentially leading to systemic crises." --T. Sabri Öncü and Viral V. Acharya, professors, Stern School of Business, New York University, July 16, 2010.
*****
"It is disconcerting that that the Act is completely silent about how to reform one of the systemically most important corners of Wall Street: the repo market, whose size based on daily amount outstanding now surpasses the total GDP of China and Germany combined." --Viral V. Acharya and T. Sabri Öncü, professors, Stern School of Business, New York University, July 16, 2010.
*****
"... it is imperative for policymakers to assess whether shadow banks should have access to official backstops permanently, or be regulated out of existence." --Zoltan Pozsar, Tobias Adrian, Adam Ashcraft, Hayley Boesky, Federal Reserve Bank of New York, July 2010.
*****
“The potential for the tri-party repo market to cease functioning, with impacts to securities firms, money market mutual funds, major banks involved in payment and settlements globally, and even to the liquidity of the U.S. Treasury and Agency securities, has been cited by policy makers as a key concern behind aggressive interventions to contain the financial crisis.” --Task Force on Tri-Party Repo Infrastructure, May 17, 2010.
*****
"Banks should have learned by now it's dangerous to rely on overnight lending." --Allan Meltzer, Professor of Political Economy, Carnegie Mellon University, March 28, 2010.
*****
"This banking system ‐‐ repo based on securitization ‐‐ is a genuine banking system, as large as the traditional, regulated banking system. It is of critical importance to the economy." --Gary B. Gorton, Professor of Management and Finance, Yale School of Management, February 20, 2010.
*****
"I think we were primarily focused on the potential collapse of the short-term funding markets, particularly the overnight repo markets and tri-party repo markets, which would have created a contagion to many other firms."--Federal Reserve Chairman Ben Bernanke, November 17, 2009.
*****
"The best thing to do with the shattered Humpty-Dumpty of mortgage securitization would be to toss the broken pieces into the garbage." --Arnold Kling, Mercatus Center, George Mason University, September 28, 2009.
*****
"Given its size and importance, it is surprising that repo has such a low profile; for example, there is little discussion of it in the financial press." -- Moorad Choudhry, Head of Treasury, Europe Arab Bank plc, London, "The REPO Handbook," September 2009.
*****
“Our regulators allowed the proprietary trading departments at investment banks to become hedge funds in disguise, using the ‘repo’ system - one of the most extreme credit-granting systems ever devised. The amount of leverage was utterly awesome.” --Charles T. Munger, chairman Berkshire Hathaway Inc., Spring 2009.
*****
"Repo borrowing is now by far and away the most important form of short-term finance in modern financial markets.." -- Alistair Milne, Reader in Banking and Finance, City University, London, "The Fall of the House of Credit," March 2009.
*****
“This helps explain how a relatively small quantity of risky assets was able to undermine the confidence of investors and other market participants across a much broader range of assets and markets.” --Timothy Geithner, president, Federal Reserve Bank of New York, June 9, 2008.
*****
"Until recently, short-term repos had always been regarded as virtually risk-free instruments." Federal Reserve Board Chairman Ben Bernanke, May 13, 2008.
*****
"The repo market is as complex as it is crucial. It is built upon transactions that are highly interrelated. A collapse of one institution involved in repo transactions could start a chain reaction, putting at risk hundreds of billions of dollars and threatening the solvency of many additional institutions." --U.S. Senate report, 1983.
*****
"Because of this widespread use in very large amounts, it is important that the repo market be protected from unnecessary disruption." --Paul A. Volcker, Chairman, Federal Reserve Board, September 29, 1982,
*****
"With a repo loan, financial institutions could make or buy more home loans, to pool and produce more securities, to use as collateral for more repo loans. It was a neat, self-sustaining cycle of profitability and a serious growth machine." --About Repo, RepoWatch.
*****
"Surprisingly, financial institutions that said they used securitization to offload risk had actually done just the opposite. Instead, it was the repo lenders who had no skin in the game." --About Repo, RepoWatch.
*****
"Repo, then, was the main way that defaults in the housing market became a full blown credit panic. It was the key transmitter that carried the shock wave from the defaulting homeowner through the canyons of Wall Street to the American taxpayer." --About Repo, RepoWatch.
*****
"In the savings and loan days, we called it Cash for Trash. In those days, thrifts lent borrowers more money than they needed and required the borrower to use it to buy a troubled property on the thrift’s books. Today, banks make repo loans to borrowers who use the money to buy troubled mortgage securities on the banks’ books, and then they use the troubled securities to collateralize the original repo loan from the bank." --Inside Jobs, RepoWatch.
*****

New to Repo?

Start with "About Repo" in the header above.

What’s $1 trillion?

Spending at $1 a second, it would take you 31,710 years to spend $1 trillion. -- Repo is $7 trillion. (See "About RepoWatch.")

Breaking News

November 27, 2016: To get around regulations intended to limit risky lending, some Chinese shadow bankers are "buying stock" which the seller agrees to repurchase with interest on a certain date. This is an effort to make a (repo) loan appear to be an investment, wrote Gabriel Wildau for the Financial Times.
*****
November 18, 2016: The Federal Reserve has become the biggest player in the repurchase market, using the vast trove of securities it acquired during the financial crisis as collateral for loans, for example from money market funds, wrote Bradley Keoun at TheStreet. Critics say this crowds out private companies, distorts pricing, and could make the Fed vulnerable to a financial crisis, as Lehman Brothers was.
*****
November 16, 2016: As part of "The Minnneapolis Plan To End Too Big To Fail" by the Federal Reserve Bank of Minneapolis, shadow banks would have to pay a tax on borrowing of 2.2 percent if they're systemically important and 1.2 percent if they're not. The purpose of the tax is to discourage borrowers from migrating from banks to shadow banks.
*****
November 10, 2016: The introduction in 2012 of the supplementary leverage ratio as a way to strengthen banks in times of stress may instead cause broker-dealers affiliated with bank holding companies to use riskier securities as repo collateral and result in more nonbank dealers doing repurchase transactions, wrote researchers at the Office of Financial Research.
*****
November 9, 2016: Expect Republicans to undo major portions of financial regulation enacted in the last eight years, wrote Josh Galper at Securities Finance Monitor. "Hold on to your seats" and "the right balance needs to be found between global risk management and free-wheeling markets," he wrote.
*****
November 7, 2016: Wells Fargo has nearly tripled its repo lending since 2013 while other large banks with lower levels of capital have been cutting back, wrote reporter Bradley Keoun with TheStreet.

Search RepoWatch

Search for:

Follow Blog

Enter your email address to follow this blog and receive notifications of new posts by email.